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What Tesla's New Battery Deal Means for the Automaker's Future

Tesla may be ready for prime time.

Tesla's (NASDAQ:TSLA) production is gearing up for a jump-start. The electric car company has General Motors (NYSE:GM) and Ford(NYSE:F) already sweating volts, and now, a recently expanded supply agreement with Panasonic for electric car batteries may signal that Tesla's ready for prime time production.

The news On Oct. 30, in separate press releases, Tesla and Panasonic each announced a four-year extended supply agreement for automotive-grade lithium-ion battery cells. Tesla claims the agreement will "accelerate the market expansion of electric vehicles" on top of its already increasing production. Both companies claim they have worked together to develop a battery that "provides the highest energy density and best performance cells in the market."

As a result, the Tesla model S has a fully charged range of up to 265 miles. This long range allows Tesla a better chance to effectively compete against gas-powered vehicles from General Motors and Ford.

Tesla is targeting a gross profit margin of 25% in the current quarter --roughly double that which is typical of General Motors or Ford. General Motors' gross profits from its automobiles fluctuated from 12.4% in 2011 to 6.7% in 2012. So far in 2013, it's over 10%. Ford typically has gross profit margin percentage in the 10% to 15% range. It would be a great accomplishment if Tesla could beat General Motors and Ford by such a wide margin while still being such a young, relatively low-volume-production company.

The Panasonic supply expansion looks like a signal that Tesla is ready to ramp up production. In the third-quarter conference call, Musk mentioned that it was now only battery production holding back higher production of finished vehicles. High-volume production will help it achieve its gross profit margin targets, which dwarf the profit percentages of General Motors and Ford.

In order for Tesla to make a serious dent in the two car giants' sales, it needs strong production and demand. In the company's last two conference calls, CEO Elon Musk noted that the company has more demand than it can keep up with in terms of production. Tesla has several thousand unique parts, with only a small minority of the parts suppliers are had trouble keeping up. However, since Tesla needs every part in a car delivered and installed, a single supplier can hold up the show. In this case, it was battery supply the last part left holding them back. Tesla now has Panasonic working on solving the last bottleneck in the supply chain.

It should go without saying that since Panasonic will be producing a lot more battery cells, both it and Tesla expect the automaker to produce a lot more cars. There's an implication here that other bottlenecks must have been solved or are getting closed to being solved. After all, as Musk reminds us, he can't deliver a 99% complete car.

Musk's has a target production of 500,000 vehicles a year that would exceed the entire laptop industry in terms of lithium-ion-battery power. That means battery makers will have to significantly expand their operations. This deal with Panasonic is a step in the right direction, and the expanded infrastructure it'll require -- according to Musk, Panasonic will need to build new battery factories -- also symbolizes Panasonic's confidence in Tesla's future.

Low battery cost It's not clear whether Tesla factored the reduced cost of battery cells into its 25% gross profit margin target. In the call, Musk stated that it was working with Panasonic to improve costs of the battery cells and that higher volume production of batteries should help reduce cost per unit as well. Tesla may be looking at greater margins going forward. Another way that could allow Tesla even greater margins is if General Motors and Ford are successful with their electric vehicles. Greater production of EVs and their parts will bring costs on those components down for everybody, including Tesla.

Final Foolish thoughts Tesla is on the road to higher volume production and lower costs. With any luck, this could lead to higher profits. Pay close attention to its forecast details. Is Tesla raising its forecasts? Are margins still on track for 25% or better? Positive answers to these questions could mean that Tesla's long-term outlook remains bright.

Author

Nickey is a select freelancer for the Fool. She writes about food & beverage, dry bulk shipping, and whatever else floats her boat. After selling four successful restaurants, she turned in her knives for a pen and now puts her passion for food, hospitality, and transportation in writing. You can send email to her at nickeyfriedman@gmail.com
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